ROI-Oil shock turbocharges Asia FX intervention risk: McGeever
Since the Iran War broke out, several Asian countries have intervened on the foreign exchange market to support their currencies. It's unlikely that they will be the last.
Asia, which imports 60 % of its crude oil from Middle East, is most vulnerable to the energy shock caused by the Iran War. Brent crude prices have increased by 55% since the conflict began on February 28.
Many Asian countries are now facing a dooms 'loop' of rising energy prices, imported inflation and demand destruction, as well as weakening currencies, which could spiral quickly if not stopped.
The MSCI emerging markets currency index dropped 3% in march, its worst monthly performance since September 2022. Unsurprisingly, several currencies from Asian countries with current account deficits underperformed. India's rupee and Indonesia's Rupiah both fell to record lows. The Philippine peso also did not perform well.
Even nations with strong external financial balances, such as Japan and South Korea have been under attack.
The South Korean won has just reached a 17-year high, and the Japanese yen at 160 to a dollar is historically low. The yen had been struggling for some time before the Iran conflict, but the war has increased the risk. This led Tokyo's Ministry of Finance, which is in charge of the financial sector, to increase its verbal interventions to stop further weakness.
Bob Savage, BNY's head of markets macro strategy, said that many central banks in Asia face a "FX Intervention trilemma" at the moment. The energy supply shock leads to cost-push inflation, but currency transmission is problematic as the dollar bid also goes up.
The pressure on policymakers in the Middle East to intervene, and the volatility of FX markets, will increase if there is not a rapid cessation of hostilities, including reopening the Strait of Hormuz.
DOLLAR DENOMINATED DOUBLE WHAMMY
Oil priced in dollars is a double-edged sword for Asia.
The global crude oil prices have risen. Brent oil is 70% more expensive today than a year ago. This feeds into the inflation models of Asian countries. The physical shortage of crude oil on the continent also means that Asian buyers are forced to pay more for physical cargoes of refined products and physical goods. This premium over the "paper" oil price quoted on financial screens is now at record highs of up to 40 dollars a barrel.
According to Morgan Stanley economists, Asia's oil-and-gas trade deficit is about 2.1% of its GDP. The euro zone has a deficit of around 1.5%. Remember that the U.S. is a net oil and gas exporter.
Morgan Stanley calculates that, if Brent stays at around $120 per barrel and natural gases remain around $3 for every million British thermal units (BTU), Asia's energy burden will rise to 6.5% of its GDP. This is where historically demand destruction kicks in, and growth risks increase.
The base case scenario of the oil analysts at the bank is that the Strait of Hormuz will remain effectively closed until the end of April.
It is obvious that the impact will be uneven. China would be more protected, while Thailand would be exposed, as would South Korea, Taiwan and India.
SELL AMERICA? BUY LOCAL
The governments of the continent have already implemented a number of fiscal and non-fiscal measures to combat the energy crisis. These include introducing subsides, exporting fuels and releasing the nation's oil and gas reserves. But it's unlikely to be enough.
If the energy crunch persists, governments across Asia could be forced to sell their foreign exchange reserves to combat inflationary pressures. In extreme cases, they may even have to pay for fuel imports.
The recent drop in U.S. Treasuries in custody held at the New York Fed for foreign central banks indicates that the Iran War has already?prompted some reserve managers in the United States to sell dollars in exchange for local currency. Deutsche Bank analysts believe that around 80% the drop in custody holdings for March is due to Treasuries being actively sold.
Most of it will have come from Asian central bankers. If there is not a resolution to the conflict, currency interventions across the 'continent are almost certain to spread. This could trigger a greater sell-off of U.S. treasuries, and the volatile period for Asian currencies.
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(source: Reuters)
